ARRC Fallback Consultation Webinar: Securitizations Consultation Regarding More Robust LIBOR Fallback Contract Language for New Originations of LIBOR Securitizations Speakers Lisa Pendergast, Executive Director, CREFC Sairah Burki, Senior Director, SFIG January 7, 2019 Alternative Reference Rates Committee
Presentation Overview • Background o A Brief History of LIBOR o The Alternative Reference Rates Committee (ARRC) and the Securitizations Working Group (SWG) Comparison of LIBOR and the Secured Overnight Financing Rate (SOFR) o • Key Issues Addressed by the ARRC’s Securitizations Consultation o Triggers o Replacement Benchmark Waterfall o Replacement Benchmark Spread Waterfall • Seeking Your Feedback: Reviewing Key Consultation Questions for the Securitization Industry • Next Steps Alternative Reference Rates Committee 1
Background
A Brief History: How We Got Here The London Interbank Offered Rate (LIBOR) has been called the world’s most important number • o Quoted daily across 5 currencies & 7 maturities, LIBOR underpins hundreds of trillions of dollars in contracts around the world from residential to commercial mortgage loans to complex derivatives to credit cards and auto loans • LIBOR-related scandals and concern that LIBOR was based off an inadequate number of underlying transactions led to the passage of several reforms to strengthen the system In 2012, the newly-created Financial Conduct Authority (FCA) was given regulatory oversight of LIBOR o o In 2014, Financial Stability Board (FSB) published a report recommending the transition away from LIBOR to new reference rates supported by actual market transactions as opposed to bankers’ judgments ( http://www.fsb.org/2014/07/r_140722/) o Thereafter, regulatory bodies and governmental agencies around the world began in earnest to identify these new reference rates • On July 27, 2017, Andrew Bailey, Chief Executive of the FCA, announced that the FCA would no longer compel banks to submit quotes for LIBOR after 2021 o The announcement further galvanized global efforts to transition to these new reference rates Alternative Reference Rates Committee 3
LIBOR Only Exists if Banks Submit Quotes; They Won’t Have to After 2021 • More than $200T of USD LIBOR contracts $200 Trillion of LIBOR-Based Contracts outstanding • However, the median daily volume of three- month funding transactions (three-month LIBOR is the most heavily referenced tenor of USD LIBOR) is less than $1 billion, and there are many days with volumes of less than $500 million • Any abrupt cessation of LIBOR, a less than robust rate as noted earlier, could create material risks for the $200T of outstanding Priced off less than $1B of contracts daily interbank USD LIBOR trading or a ratio of 200,000 to 1 Alternative Reference Rates Committee 4
Beyond LIBOR: Firms Must Start to Prepare if They Haven’t Already The UK’s Financial Conduct Authority said it would not compel panel banks to submit quotes to the range of LIBOR currencies after 2021, leaving less than three years to prepare for transition to a new benchmark rate • “I hope it is already clear that the discontinuation of LIBOR should not be considered a remote probability 'black swan' event . Firms should treat it is as something that will happen and which they must be prepared for.” Andrew Bailey, Chief Executive of the Financial Conduct Authority • “ The public and private sector share the recognition that there is a strong possibility that LIBOR may discontinue, and the associated risks are considerable . That’s why these consultations for fallback contract language are a crucial development in creating a more resilient financial regime.” Sandra O’Connor, Chair of the Alternative Reference Rates Committee and JPMorgan Chief Regulatory Affairs Officer “Internally , if you have not already done so, mobilize a formal transition program in your firm , bundle your arrows. In that bundle, • include a budget with ample resources, a governance structure, and work streams with clear mandates to: conduct impact assessments; develop inventories of legacy exposures and contracts that mature after 2021; prepare for new products and financial instruments that will be linked to the new [risk-free rates]; and develop internal education and client outreach and communication plans .” Rostin Behnam, Commissioner of the Commodity Futures Trading Commission Alternative Reference Rates Committee 5
About the Alternative Reference Rates Committee (ARRC) ARRC Members • What is the ARRC? AXA JP Morgan o In November 2014, Board of Governors of the Federal Reserve Bank of America LCH System and Federal Reserve Bank of NY formed the ARRC to BlackRock MetLife identify a replacement rate for USD LIBOR Citigroup Morgan Stanley CME Group National Assoc. of Corp. Treasurers • Comprised of financial institutions, trade associations, official sector Deutsche Bank PIMCO Fannie Mae TD Bank • Initial charge was to determine a new reference rate to replace LIBOR Freddie Mac FHLBNY GE Capital Independent Community Bankers of America • ARRC originally focused on the derivatives market Goldman Sachs LSTA In June 2017, ARRC selected SOFR as its preferred replacement rate • Govt Finance Officers Assoc. SIFMA HSBC Wells Fargo • In March 2018, ARRC was reconstituted to develop strategies to Intercontinental Exchange World Bank Group facilitate the transition from LIBOR across cash products: ISDA ARRC Ex-Officio Members o Floating rate notes (FRNs) CFTC Board of Gov. of the Federal Reserve System o Syndicated business loans CFPB Office of Financial Research FDIC Office of the Comptroller of the Currency Securitizations o FHFA SEC o Consumer products Federal Reserve Bank of NY U.S. Treasury Department o Bilateral business loans Alternative Reference Rates Committee 6
ARRC’s Focus on Cash Products • ARRC mandate for Cash Markets o In the Spring of 2018, the ARRC organized Cash Market Working Groups for each product area to develop strategies to transition from LIBOR as appropriate o Working groups specifically tasked with producing a “consultation” for public comment that would help address risks in contracts referencing LIBOR and outline the steps for an effective transition from LIBOR o For Securitizations, the ARRC selected the CRE Finance Council (CREFC) and the Structured Finance Industry Group (SFIG) as co-chairs of the Securitizations Working Group (SWG) o Note that the SWG Consultation also incorporates the views of the Loan Syndications and Trading Association (LSTA) and its members as it relates to corporate CLO securitizations Alternative Reference Rates Committee 7
ARRC’s Securitization Working Group • Composition of the ARRC’s Securitizations Working Group (SWG) is varied and attempts to cover as much of the securitization markets as possible o SWG is comprised of the leading lenders, investors, advisors, and associations across the securitization market and numbers over 60 companies. SFIG and CREFC are extremely grateful for all the time and effort put into this Consultation. o Focus of the SWG is to help the securitization markets transition from LIBOR with minimum disruption to the securitization markets Securitizations Working Group Member Companies AIG Citi GM Financial Morgan Stanley State Street Annaly Credit Suisse Goldman Sachs Morningstar TIAA AXA CREFC Guardian Natixis TPG Bank of America Dentons HSBC Navient US Bank Bank of the West Deutsche Bank Huntington New York Life Vanguard Barclays Discover JP Morgan Nomura Volvo Berkadia Fannie Mae Key Bank PIMCO Wellington BlackRock Federal Reserve Bank of NY Kroll PNC Wells Fargo Blackstone FHFA LSTA Prudential Wilmington Trust Board of Gov. of the Federal Reserve FHLB Met Life RBC Brighthouse Financial Fitch Mizuho S&P Cadwalader Ford Moody’s SFIG Chatham Financial Freddie Mac Morgan Lewis SIFMA Alternative Reference Rates Committee 8
Why LIBOR I s No Longer Viable…and Why the ARRC Chose SOFR • “LIBOR is measuring the rate at which banks are not borrowing from one another,” Andrew Bailey, FCA Globally, policymakers have looked for robust, highly traded replacement rates Daily Volume in U.S. Money Markets over 1H 2017 (billions) $754 $800 • Almost all liquidity and trading is in $700 overnight markets $600 $500 • U.S. selected SOFR: $400 $300 Combination of 3 Treasury repo rates $197 o $200 $79 $100 Very deep, very liquid; $800 billion of $13 o $0.5 $0.3 $0.1 $0 daily trading vs <$1 billion in 3M LIBOR Secured Overnight Overnight Bank Effective Federal 3-Month Treasury 3-Month LIBOR 3-Month AA 3-Month A2/P2 Financing Rate Funding Rate Funds Rate Bills Nonfinancial CP nonfinancial CP • Why not other rates? (SOFR) Median Daily Number of Unsecured Wholesale Borrowing Transactions Observed for USD LIBOR Panel Banks Fed Funds – <$80 billion of trading; o 1-Month LIBOR 3-Month LIBOR 6-Month LIBOR 1-Year LIBOR fewer counterparties and highly reliant 2017 Q1 6 6 3 1 on GSEs; using a policy target rate 2017 Q2 8 6 3 0 could have monetary policy implications 2017 Q3 7 5 2 1 2017 Q4 9 6 2 1 T-Bills – Insufficient daily trading 2018 Q1 7 8 3 1 o 2018 Q2 5 7 2 0 Source: Federal Reserve Bank of New York; Financial Industry Regulatory Authority; DTCC Solutions LLC, an affiliate of the Depository Trust & Clearing Corporation; and the Board of Governors of the Federal Reserve System Alternative Reference Rates Committee 9
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